5 steps to build your revenue recognition strategy
Revenue recognition is at the heart of accounting for SaaS and subscription companies. But it is complicated. However, you can quickly study and optimize your unique version of calculating deferred revenue.
Doing so is practically always worth the investment because:
- It saves time and money. If you haven’t examined and streamlined your revenue recognition process, odds are at least decent that you’re throwing more resources at particular stages of it than you need to. Examining your process in more detail allows you to correct this.
- It enhances your strategic bandwidth. Once you’ve streamlined your revenue recognition, you’ll have more time to focus on big-picture questions around strategic leadership.
- It makes getting ASC 606/IFRS 15 compliant a breeze. And just as importantly, being aware of these issues is essential to staying compliant with industry regulations such as ASC 606. An automated accounting suite like Sage Intacct can also be a significant asset here.
Let’s dive deeper into how you can improve your revenue recognition strategy.
The 3 Pillars of Revenue Recognition: Timing, Amount, and Uncertainty
When it comes to tracking revenue recognition as a SaaS CFO, everything boils down to three central pillars:
- Amount. How much revenue are you recognizing, and what does this amount obligate you to do in return (i.e., what is the amount of your obligation)?
- Timing. In what timeframe is this revenue due to be recognized?
- Uncertainty. Are there any problems that might interfere with the timely and effective recognition of your revenue?
Now that you know about the three pillars of revenue recognition under ASC 606, let’s build a specific 5-step roadmap you can follow for seamless revenue recognition.
- Step 1: Identify all the contracts you have in place with your customer. This is the bedrock of the entire process.
- Step 2: Identify the separate and specific services you are obligated to perform under your contract.
- Step 3: Note the exact transaction price you and your customer have agreed on for these specific services.
- Step 4: Deliver the services your contract obligates you to.
- Step 5: You may now recognize the revenue for the services outlined in the contract.
This all seems pretty straightforward, and for the most part it is. But it’s beneficial to examine a few definitions more closely.
Getting Some Key Definitions Straight
The five steps we outlined above hinge on two central definitions: “performance obligation” and “commercial substance.”
We’ll start with the former. With respect to ASC 606, a performance obligation is defined as whatever service or services you promised to your customer in your service contract.
A service obligation can also be implicit, based on how you ordinarily conduct business. For instance, if you customarily waive a specific fee for your customers, that could be considered an implicit obligation.
At this point, you might be wondering, “Which of my performance obligations am I legally required to report?” It all depends on whether those particular promises have commercial substance, which brings us to our second definition.
It may sound fancy, but “commercial substance” just means that a particular promise of services impacts the amount, timing, or certainty of your company’s cash flow.
In plainer terms, if a service obligation affects or contributes to your bottom line, you have to report it.
Identify Your Exact Performance Obligations
The final step to transforming revenue recognition from a chore into a breeze is to take careful and detailed stock of exactly what you owe your customer. What precise obligations have you promised them in your contract?
Any SaaS CFO needs to spend time thinking about this because:
- Performance obligations often exist in groups or clusters. Sometimes this isn’t the case, and your obligations are fulfilled with a standalone subscription, for instance. But many times, one performance obligation is linked to another.
- Every performance obligation is a chance to strengthen your company’s bond with its customers. The immediate and “technical” reason to analyze your performance obligations is that doing so facilitates accurate revenue reporting. But the “human” element is that the process allows you to better serve your customers.
- It’s far easier–and cheaper–to satisfy and upsell existing customers than to chase new ones. This means serving and pleasing your existing roster of customers should always be a top priority.
Once you’ve followed these three steps, hopefully you’ll see ASC 606 in a new light. Instead of a regulatory headache, try to look at it as a gateway to achieving better customer relationships through superior service.
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